As of mid-November 2023, UK inflation is 6.7%, a considerable step down from October 2022 levels, when it hovered at about 11.1%. One of the key factors that has influenced this decline is the Bank of England’s interest rate history with its long-term and consistent monetary policy tightening.
This has forced the UK economy to the brink of recession and slowed down growth considerably. However, BoE governor Andrew Bailey has highlighted that this is, unfortunately, a necessary price to pay in the short term so that inflation can return to the 2% target.
The UK is not the only country to see an increase in economic slowdown, with a similar pattern being seen globally, especially in the US and China. China’s slowdown is especially relevant, as the UK relies heavily upon the country for several goods.
The increase in global conflicts, such as the Russia-Ukraine and Israel-Hamas wars, is also concerning at a time when the UK economy is already considerably weakened in the last two or three years. As such, a new European or Middle Eastern conflict can further hurt the UK economy through energy and food price increases.
Unemployment levels have also risen in the UK lately, hiking to 4.2% in the three months ending June to September 2023. These account for about 1.44 million people unemployed, which is about 69,000 more than pre-pandemic levels.
Unemployment levels have also risen in the UK this year, hiking to 4.2% in the three months to October 2023.
Has UK Inflation Already Peaked?
UK inflation could have peaked in October 2022, when it touched a high of 11.1%. However, the Bank of England and institutions such as the British Chamber of Commerce may not be so quick to rejoice. This is because future monetary policy decisions depend entirely on new economic and labor market data.
Chart: United Kingdom Inflation Rate
Bailey has already highlighted that it is “really too soon” to consider interest rate cuts. This is because inflation at 6.7% is still quite far from the bank’s 2% target, and there is still much work to be done. Economic conditions are also quite volatile.
In case the current Israel-Hamas war spirals into a wider Middle-Eastern conflict, energy prices may skyrocket once more, thus translating to more UK inflation. This may also lead to other commodity prices, such as food and metal, to follow suit.
Projected Interest Rates in 5 Years in the UK
The UK base rate forecast for the next five years may be crucial for the nation’s market to recover from the effects of the last few years.
One of the main factors that will influence UK interest rates in the next five years is the growth rate of the economy. The country’s growth is already one of the slowest among the G7 members.
According to the International Monetary Fund, UK growth is forecast to be about 0.4% in 2023, growing a little to 1% in 2024.
Sluggish UK Growth Could Cause Pauses in Interest Rate Hikes
If UK growth continues to flag, policymakers may be forced to consider a pause or hiatus in interest rates. This could be once inflation is more manageable and could very well be before it reaches the 2% target. This is because, at the current slowing growth rate, the nation’s economy may not have the luxury of sacrificing growth further for inflation.
Speaking of the UK interest rate forecast for the next 5 years, Piero Cingari, staff writer at financial news outlet Benzinga and former macroeconomic analyst at Capital.com, notes:
“Five years already constitute a significant timeframe in the world of financial markets. If we reflect on the state of the world five years ago, we were grappling with negative interest rates in a substantial portion of the Western world. Inflation was virtually absent. There were also no wars on Europe’s doorstep nor a global pandemic.”
He added: “Many profound changes have occurred over just five years, rendering any predictions today regarding interest rates in the next five years somewhat speculative.”
“Currently, the interest rate market is factoring in a potential reduction of approximately 200 basis points in the Bank of England’s rates between 2024 and 2025. This is broken down into an anticipated 70 basis point reduction in 2024 (equivalent to nearly three 25 basis point cuts) and a further 125 basis point reduction in 2025 (equivalent to six 25 basis point cuts).
“Should the market’s pricing turn out to be accurate, interest rates in England would likely decrease to approximately 3-3.25% by the end of 2025. Beyond this timeframe, making precise forecasts becomes increasingly challenging. What appears to be gaining traction is a shift away from the pre-pandemic and post-financial crisis era, when interest rates remained near 0%.
“That era was characterized by trade liberalization. Reduced geopolitical tensions meant that inflation was consistently falling below central bank targets. If this period represents just a historical window, it is plausible to anticipate that central banks may opt to maintain positive interest rates in the years ahead,” Cingari explains.
Syed Muhammad Osama Rizvi, macroeconomic and energy analyst at Primary Vision Network, also supports this view. He highlights: “The global monetary policy tightening is expected to prolong on the back of uncertainty and volatility, especially in the global energy markets.
“The core inflation levels are still high in many developed parts of the world. UK’s case is unique in that the economy has not been doing very well. It is probably one of the worst in the advanced economies.
“I believe the UK will soon start to unwind its rising interest rate policy, the country already seems to be on the cusp of recession. We can expect an expansionary monetary policy moving forward.”
ING also predicts that UK interest rates should be about 4.5% in the first quarter of the following year, going down to 4% by the end of 2024. By the end of 2025, the bank sees interest rates at around 2.4%.
The Bank of England May Not Agree to a Reversal So Soon
However, the Bank of England may not agree to a reversal of rates quite so soon. Since the pandemic began, the official stance has been aggressively hawkish, in line with the US Federal Reserve.
The BoE has hinted that it may consider keeping rates on hold until at least August 2024. This is to see how inflation and the broader economy react. However, this is far from set in stone.
The bank has highlighted that monetary policy must likely continue to be tight for the foreseeable future.
As such, it has highlighted that rates are more likely to go further up than come down. They are constantly subject to scrutiny, depending on new economic data.
Bailey recently spoke at the second Financial Services Conference at the Central Bank of Ireland in Dublin. During the speech, he signaled that there are still considerable “upside risks” to interest rates. He also said the Bank of England is “not talking about” laxer monetary policies.
The increased fragmentation in the global economy also fuels the upside risks he referred to. He also mentions that the UK’s economy has been more closeted following Brexit. The Russia-Ukraine war also highlighted this, making it evident just how much the UK relied on Russia for energy.
This has led to the UK realizing the need for diversification in trading partners.
Policy Changes Could Impact Interest Rates
The UK is in dire need of specific key policy changes for businesses. This is because profit margins have eroded significantly following the pandemic and the price shocks due to geopolitical events. This has also led to several companies reducing output, shutting down production completely, or outsourcing to cheaper countries.
The UK government may need to bolster local businesses through increased stimulus measures, tax breaks, and loans, amongst others. This, in turn, will help enterprises to better manage expenses. As a result, they will also pass on fewer costs to consumers, thus decreasing cost-push inflation.
Similarly, the UK plans to implement increased support measures for unemployed youths. This includes career counseling, better help with degrees, student loans, and more mental health support. As a result, the unemployment rate may also fall considerably.
These measures, or lack thereof, could go a long way in impacting inflation rates and the resulting monetary policy.
UK Interest Rate History
The UK interest rate history in the post-pandemic period has been quite rocky — over the past two years, the Bank of England has hiked interest rates 14 times.
This started in December 2021, bringing the current UK interest rate to 5.25%. This was done both in aggressive 0.50% hikes and a few more gentle 0.25% hikes, as the month-to-month situation demanded.
However, in the last two monetary policy meetings, the BoE has chosen to hold rates stable.
This spate of rising UK interest rates was due to several factors. Amongst these, soaring inflation and the energy crisis were significant factors, especially during the pandemic. The surge in demand following the lockdown restrictions also worsened inflation.
This was especially true since businesses struggled to get production back on track following profit margin cuts during the pandemic.
The Russia-Ukraine war was another shock, leading to rising energy prices and inflation. The conflict also caused considerable supply chain blockages and soaring food and input material costs.
Following the pandemic, the UK workforce also shrank considerably as more people suffered from long COVID-19 or cared for loved ones. Many others were laid off or could not afford childcare costs anymore. This increased labor costs proportionately as employers struggled to find skilled labor.
In turn, they passed on the costs to final consumers, thus perpetuating the inflation cycle.
What is the Bank of England (BoE)?
The Bank of England, or the BoE, is the UK’s central bank. It is responsible for developing monetary policy and keeping tabs on other banks in the UK, amongst other things. The bank is also responsible for regulating the money supply.
It is also a regulator for payments and financial systems and acts as a watchdog to ensure financial fraud and crime are controlled. The BoE also sets UK interest rates and inflation targets and works towards meeting them through various methods.
This can include raising or lowering interest rates as needed. Furthermore, it can also help bail out other banks if they are struggling.